Thou shalt not split 60/40

Ready or not, the traditional portfolio mix of stocks, bonds and cash is becoming a thing of the past. In its place will be a much more diversified asset allocation strategy that relies on a recent influx of alternative investing products once thought to be the domain of only the very wealthy.

“As we continue to see high volatility, more and more people are going to gravitate to the alternative bucket to try to quiet down the volatility and create some return,” says Howard Atkinson, chief executive at Horizons Exchange Traded Funds. “I think we are just at the early adoption stage.”

‘If you still say 60/40 worked for my grandfather so it’s good enough for me, that’s a dinosaur approach’

While institutional investors, including the country’s biggest pension funds, and high-net-worth individuals have long embraced hedge funds, managed futures, infrastructure and other alternative assets, retail investors have been much slower on the take, largely because there were too few options available for them even if there was an appetite for such strategies.

But mutual fund companies and exchange-traded fund (ETF) providers are now taking advantage of regulatory changes and product innovation to introduce alternative investing strategies to the masses.

Mackenzie Investments, for example, in April allowed the majority of its mutual fund managers to short sell in their portfolios. The permission follows an industry-wide amendment that allows mutual funds in Canada to engage in short selling up to 20% of a fund’s net asset value with the proviso that no single short position exceed 5% of the fund’s net asset value. Mutual funds are also required to maintain cover for short positions with cash equal to 150% of the aggregate market value of the shorted securities.

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“Our portfolio managers are constantly researching securities of all types,” Mackenzie said at the time. “Often, they find overvalued securities that they believe are set to decline in value, but previously there wasn’t a direct way for our investors to benefit from this research.”

Other mutual fund companies have gone even further in introducing alternative strategies. BluMont Capital Corp. now offers a global and Canadian long/short fund, which involves buying long equities expected to increase in value and selling short equities expected to decrease in value. It also runs the country’s only daily liquidity market neutral fund, a global infrastructure fund that was introduced last summer and a managed futures fund run by sister company Integrated Managed Futures Corp.

Alternative closed-end funds, designed to provide a portfolio manager relatively permanent capital in order to access investments that are less liquid, are also proliferating as are alternative ETFs.

First Asset Funds recently launched JFT Strategies Fund, a long/short fund managed by hedge guru Jean-Francois Tardif, while Barry Allan, another highly regarded Canadian investor, introduced a multi-strategy income fund under the Marret Asset Management banner in March 2011.

On the ETF side, Horizons now has both managed futures and hedge fund replication index products, while iShares has added a managed futures fund to its lineup.

David Kaufman, president of Westcourt Capital Corp. in Toronto, said the rise in alternatives is a welcome development for retail investors who have grown tired of the fragile returns being generated by traditional stocks and bonds.

He said the near-ubiquitous practice of allocating 60% of an investor’s holdings to equities and 40% to bonds — or some slight variation of that mix — worked well for the 30 years before the financial crisis, but not so much since then.

“I quite often joke that Moses came down from Mount Sinai with two tablets and one said 60 and the other said 40. People are that dogmatic about it,” he said. “But now we are at a point, where the 60% in stocks is highly volatile and you have to endure this only to achieve anaemic returns. Then on the fixed-income side, you are looking at extremely low returns, even negative real returns. You stand back and say: 60% of my portfolio is brutal, and the other 40% is not going to work.”

Mr. Kaufman believes that alternative strategies, particularly those uncorrelated to equity and bond markets and, therefore, offer some level of downside protection, is the key to generating market-beating returns.

“I understand it may take more time to develop a comfort level with alternatives, but if you still say 60/40 worked for my grandfather so it’s good enough for me, that’s a dinosaur approach,” he said.

Mr. Atkinson said ongoing market turmoil because of Europe’s ongoing crisis and unease about the global economy is forcing investors around the world to reduce their equity exposure. But bonds look just as risky since current ultra-low interest rates are expected to rise over time.

“Sovereign bonds used to be risk-free return, now they are return-free risk’” he said, quoting James Grant, the founder of Grant’s Interest Rate Observer. “That leaves this whole alternative space to fill the void where I can try to generate some absolute returns.”

Many investors Mr. Atkinson has spoken to over the past year are already allocating up to 30% of their portfolios to alternative investments and he expects the shift will continue to broaden across the retail investment spectrum. He noted a recent forecast from Cerulean Associates that predicts alternative mutual funds will increase to 15% from 3% of the industry’s assets in the next few years.

“If you go back through other bear periods in history, people invested differently coming out the other side than they did going in,” he said. “When we are through this, you will see your typical model portfolio will be vastly different than it is now.”

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I also accept and agree to be bound by Postmedia's Terms and Conditions with respect to my use of the Site and I have read and understand Postmedia's Privacy Statement. I consent to the collection, use, maintenance, and disclosure of my information in accordance with the Postmedia's Privacy Policy.